Microfinance finally learns to speak finance

Gotta be honest, I opened CGAP’s latest brief, “Microfinance Investment in Sub-Saharan Africa: Turning Opportunities into Reality” and the first two pages were so depressing I seriously almost stabbed my eye out with a rusty butter knife I keep handy for such occasions.

But then I got to the third page and was encouraged by what I found. Not because microfinance in Africa is booming great guns and everyone has lifted themselves out of poverty forever—it isn’t and they haven’t—but because there’s an unmistakable shift in the way the non-profit side of the industry, at least as represented by CGAP, is talking about efforts to achieve sustainability. Maybe this is a postpartum result of several years of ex-JP Morgan-now-OPIC-chief Elizabeth Littlefield in charge (if you don’t know her, Google her, she’s kind of a badass), but I’ve been watching the industry’s positioning on this for about a decade now and for the first time I…well I refrained from stabbing anyone with a rusty butter knife. That’s progress, right?
Beginning on page three, the report poses the question, “Are international investors structured well to serve the Sub-Saharan Africa market?” This question actually has a problem with its phrasing, but oddly the report then provides an answer to the very question it should have asked: where’s the local currency lending?

Because without local currency lending, all that’s left is hard currency lending, usually in US dollars, and tell me, why would a cab stand owner in Kampala want to borrow money in US dollars? The answer is he wouldn’t. Ever.

For the longest time so much of the industry on the non-profit side either turned a blind eye or remained willfully ignorant of the perils of hard currency lending. More bluntly, aside from questionable default stats, uneven pricing strategies and supposedly coercive repayment terms, the industry additionally perpetuated what I’ve always considered the grandest hypocrisy of all. On the one hand, microfinance was supposed to be about helping poor people by affording them access to finance; on the other hand, the way this was done in practice was by raising the barriers for borrowers to exit poverty by structuring loans whose values would likely inflate when repayment came due (sound familiar?).

I’m reminded of the old maxim that a banker is someone who lends you an umbrella when it’s sunny but then wants it back the moment it begins raining.

Anyway, what that thought space seemed to be filled with instead was a lot of patting each other on the back for “doing well by doing good”, “banking the unbanked”, engaging the “bottom of the pyramid” and too many other stomach-churning niceties that really, if they don’t drive you to stab your own eyes out, at least turn any financially-aware person away from all the mushmush and back to more mainstream enterprises. And the shame was that people who really understood finance were exactly what microfinance needed more of.

Amazingly, microfinance survived and in part even thrived on hard currency lending for the longest time. The few media outlets that ever bothered with this niche of the development finance universe never quite picked up on that little factoid, and then when Muhammad Yunus went to collect his Nobel prize, the media definitely didn’t pick up on it because it didn’t jibe with the nice-nice headlines. Never mind that it’s the same practice that on a larger scale has contributed to innumerable sovereign defaults and financial crises across the developing world over the past few decades.

On the for-profit side, investors understandably were growing tired of non-profiteers free from shareholder accountability hectoring them into giving away something for nothing. But it seems that not only are the conditions for both sides to come together now underway, what’s more is CGAP is picking up on it:

“Debt represents a large part of the total direct investments in the region (38 percent for DFIs—Development Finance Institions—and 70 percent for MIVs–Microfinance Investment Vehicles—as of December 2010), with a growing portion of funding in local currency. For example, in 2010, 49 percent of all direct DFI debt investment was in local currency, and this figure has risen since. Also, most MIVs have more than 50 percent of their SSA portfolio in local currency (compared to 30 percent globally), and several have a strategy to increase such funding to 100 percent, according to our research.”

Furthermore, some DFIs have Sub-Saharan Africa portfolios in which more than 50 percent is allocated to equity and higher than the overall equity share in their global portfolios. The two main factors driving this are a desire to provide patient, longer term capital so that microfinance institutions can develop, and increasing greenfield investment.

There’s still a bit of a concentration problem, but this is really a light years-type move forward. And all this despite persistent barriers to local currency liquidity:

“Investors have made noticeable strides in providing local currency funding to SSA financial institutions. However, finding affordable hedging instruments or local currency equivalent funding is often difficult. In particular, several investors noted difficulties finding price-competitive hedge rates for East Africa, the subregion where microfinance investments had been concentrated to date. Recently, high inflation in Kenya and Tanzania has dramatically pushed up interest rates, and consequently hedging costs. In Kenya, the inflation rate quadrupled to 18.9 percent during 2011. SSA had the most volatile hedge rates over the year ending September 2011.

High hedging costs have contributed to a recent reduction in the volume of loans closed for East African MFIs. Larger and more sophisticated MFIs are taking hard currency loans at lower rates, while smaller MFIs with less access to local funding are forced to pay much higher rates on properly hedged loans. Most investors anticipate that the cost of hedging in East Africa, and in a few other SSA countries, will not return to reasonable levels until 2013.”

It isn’t quite the promise land yet, but as I’ve noted previously on this theme, something is better than nothing. And what’s more is it’s actually being openly discussed as a risk.